Wednesday, April 25, 2007

Amazon.com (NASDAQ:AMZN): Shorting opportunity

Lots of positive commentary on Amazon.com (NASDAQ:AMZN) today after the co released stronger than expected Q1 results and raised guidance for both Q2 and YE07. We have at least 2 upgrades with estimates and price tgts raised across the board. There seems to be only one major firm out there that is keeping its cool. It's JP Morgan:

- JPM's Imran Kahn notes that after three straight quarters of 100+ bps Y/Y declines, gross margins in 1Q07 fell only 17 bps. While sales mix and lowered prices still pressured margins, growing third-party sales internationally slowed the decline. Continued growth in 3P units internationally is a key lever for moderating gross margin erosion. Looking forward they think gross profit margins will decrease 40 basis points Y/Y in F07 due to the impact of seasonal mix shift toward EGM in 2Q and Harry Potter book sales in 3Q (expected to be sold at 46% discount).

Although the International segment benefited this quarter from an increased mix of third party units from traction in Merchants@ and an acceleration of units sold, the firm believes this dynamic may impact AMZN's ability to show continued strong organic revenue growth.

Amazon's 1Q'07 tax rate was 23%, significantly lower than its 2006 effective tax rate of 50% and its 42% tax rate for the fourth quarter. As JPM was modeling a 35% tax rate for the first quarter, AMZN delivered GAAP EPS $0.07 above their expectations on the basis of the tax change alone. Amazon's 4Q topline results of $3.02B include an $84M Y/Y positive impact from foreign exchange. AMZN had more than 66M active customers at the end of the quarter, up 15.8% Y/Y - slowing somewhat from previous quarters.

Is Amazon a Buy? They think valuation is too rich. While AMZN's 1Q was solid, they think the valuation may not offer much upside. The stock is trading 50x firm's F07 GAAP earnings estimates, compared to its peers which are trading at 41x F07 GAAP estimates. Maintain Underweight rating.

Notablecalls: Looks like AMZN managed to pull a pretty decent quarter. While the whisper numbers indicated some upside, it was viewed largely as priced in already. I happen to know some pretty savvy market participants that were short the name going into the release. Overall, I suspect that absent the fairly large short lines, the stock would have been up no more than say 2-3 bucks in after hours action. With the help of some panicky shorts, the stock ended up almost 6 bucks.

Looking at the numbers, couple of things stick out:

- Approximately half of EPS (GAAP) upside came from the lower tax rate. Also, favorable FX contributed most of the revenue upside. Absent these two, AMZN would have posted just a slight or normal beat.

- 3rd party business helped the margin performance. Based on what I've heard, margins are shrinking there as well (for the merchants). So, I'm not entirely sure the upside from 3P is sustainable.

Most of the analyst community is going ga-ga over the results, with Piper Jaffray upgrading their rating, just after downgrading the stock on Monday. You probably already know how I feel about stuff like this. Also, Citi is upping their rating to Hold from Sell. Most targets go to the $50-$55 range with one exception. A large tier one firm is upping their tgt to $60.

Yes, I do think AMZN's a short at around $50.30 (last prints in after hours). Even the most bullish analysts see only 10-20% upside from these levels, which is likely not enough to compensate for the risks. This, coupled with what I consider to be poor quality of upside in results pretty much caps any further upside in the stock.

Given there are still many shorts in the name, I would scale in to the short squeeze.